For 2021–22 we estimate a net small business income tax gap of $17.7 billion or 12.6%. This means we estimate around 87% of the total theoretical tax was paid. This gap forms part of our overall tax performance program.
Small business population
The small business population comprises a diverse range of structures and operations. It covers businesses with a turnover of up to $10 million.
Small business operating structures include:
- companies
- sole traders
- trusts
- partnerships.
There are around 4.7 million small businesses in Australia, plus a further 2.5 million individuals that are linked to a business (for example, as a director, shareholder, partner, or beneficiary).
The taxation of small business differs depending on the structure of the business, turnover and relevant tax rates for the income year.
When calculating the income tax gap, our primary focus is on entities that have an income tax obligation. In our small business population, this includes:
- companies with a turnover up to $10 million
- individuals associated with small business entities including partnerships, trusts and companies with a turnover up to $10 million
- sole traders receiving business income up to $10 million.
The small business income tax gap forms part of our overall tax performance program. Find out more about the concept of tax gaps and the latest gap available.
About the estimate
The preliminary estimate for the 2021–22 small business income tax gap is based on 1,235 case results from 2 years of data collected through the random enquiry program. This estimate is subject to revision. Future updates are expected to include approximately 1,900 case results from 3 years of data. The additional case results are expected to increase the reliability of the estimate.
Tax gaps expressed as a percentage are typically regarded as the best measure of system performance.
In measuring the small business tax performance, our preliminary 2021–22 estimate net gap percentage has decreased compared to the updated 2020–21 estimate. This is because the theoretical liability has grown more than the net gap amount.
This may be attributable to a range of factors, including:
- economic factors
- possible changes in compliance
The sample size informing this estimate is larger than that used in the preliminary 2020–21 estimate published in 2023 and approaching the size of the samples used in earlier estimates. The sample sizes for 2018–19 and 2019–20 was reduced as a result of COVID-19. We will continue to build a more complete picture of the overall tax performance for small businesses as more data becomes available.
A revised debt methodology is under development that considers external economic factors and internal changes to provide a more contemporary estimate of the amount of debt that will likely never be paid. This year’s small business income tax gap estimates maintain the current approach to debt with a reduced reliability rating to reflect that improvements in this component of the methodology are required.
Table 1 shows:
- Compared to the 2020–21 estimate, in 2021–22, the voluntary expected collections (expected collections minus amendments) increased by 18.3% and the population has increased by 7.2%. The growth in voluntary expected collections and growth in population include uplifts applied for pending lodgments to the ATO. These shifts have contributed to the growth in both the theoretical liability and the dollar net gap. The stronger growth in expected collections, driven by voluntary amounts, has caused the net gap, as a proportion of theoretical liability, to decline. Since the 2021-22 estimate is preliminary, it is too early to determine if compliance has improved.
- The net tax gap ranged between 12.1% and 14.6% from 2015–16 to 2021–22.
- Over those years, tax collected for this population has increased and the overall tax gap percentage has been relatively stable.
- Previously published estimates have been revised using updated data. This includes additional random enquiry program case outcomes to support the 2019–20 and 2020–21 estimates. As a result, these revisions increased the net gap percentage, although this is not necessarily indicative of an increase in non-compliance. Some variability from year-to-year is expected and the trend continues to demonstrate a level of stability in small business tax performance.
Figure 1 displays the gross and net gap for small businesses as a percentage over the same period, the dotted line between 2020-21 and 2021-22 reflects the fact that this estimate is preliminary.
Figure 1: Gross and net tax gap percentages, 2015–16 to 2021–22
Note: The estimate for 2021–22 is preliminary and subject to revision.
Tax gap components
The main components of the small business income tax gap are:
- omitted income
- over-claimed deductions
- people outside the tax system, for example, cash-only businesses operating without an Australian business number (ABN)
- non-pursuable debt that is not economical for us to pursue.
The extent to which these components impact the tax gap varies depending on the segment of the population.
The following figures split the tax gap by population and the main drivers of non-compliance for each of them.
Figure 2: Small companies
For the companies component of the gap, omission of income accounts for about half of the overall gap (54%). Over-claimed business deductions represent nearly all the remainder of the gap (42%).
Figure 3: Individuals in business
For the individuals in business component, the main driver of the gap relates to omission of income (67%). We also recognise the influence of over-claimed deductions contributing to the overall gap.
Figure 4: Combined small business
The final combined view shows the overall influence of omitted income on the gap (65%).
Findings from the random enquiry program
Through the small business random enquiry program, we check the income tax affairs of randomly selected taxpayers for the relevant year. This helps us calculate the tax gap estimate and identify the most common issues and behaviours driving the gap.
Our refreshed 2020–21 estimate is the analysis of 1,795 taxpayers, conducted across a sample representative of the 2018–19, 2019–20 and 2020–21 small business populations.
We used data from the 2019–20 and 2020–21 taxpayer reviews and audits with lodgment data from 2021–22 to give us the preliminary tax gap estimate for 2021–22.
Our observations highlight 4 key areas that need our attention:
- continuing to address shadow economy behaviour (deliberate attempts to avoid paying the right tax)
- continuing to provide education and support to ensure small businesses are aware of and understand their tax obligations
- integrating and improving the record keeping and reporting experience for small business taxpayers
- reducing complexity, particularly around law, structures and multiple taxes.
Small business behaviours observed
Most taxpayers reviewed in the sample reported correctly or were considered to have genuinely attempted to do so.
In our random sample, we observed small businesses are getting it wrong in one of 4 ways:
- making mistakes because they don’t understand their tax obligations
- making errors because of poor record keeping
- not declaring all their business income
- other business behaviours including overclaiming expenses that are private in nature and not related to the business.
Our sample includes individuals in business. These taxpayers can have income and expenses from sources outside their business activities.
Errors in reporting income and expenses unrelated to business activities for these individuals contribute to the small business income tax gap. For example:
- under-reporting salary and wages from an unrelated entity
- under-reporting passive income from rental properties, gross interest and dividends
- miscalculating and under-reporting net capital gains
- overclaiming work-related expenses (car, clothing, travel) and gifts or donations.
Shadow economy behaviour observed
The tax effect of the shadow economy in 2021–22 is estimated to be $11.2 billion or around 59% of the gross gap. $8.9 billion of this is associated with deliberate under-reporting of income and over-claiming of deductions. The remainder is made up of hidden wages and people operating outside the tax system.
While the impacts of shadow economy behaviour are significant, the taxpayers observed to be deliberately engaging in this behaviour through the random enquiry program are in the minority. Approximately 5% of taxpayers in the sample made clear and deliberate attempts to avoid paying the right tax.
Tax practitioner behaviours observed
Most small businesses engage a tax professional to help prepare and lodge their returns, but the nature of these relationships vary significantly. We observed that small businesses who reported correctly had more regular contact with a tax professional.
We also identified instances where tax professionals:
- made mistakes because of bookkeeping and accounting system errors
- provided incorrect advice
- failed to show reasonable care.
In approximately 40% of cases where there was evidence of shadow economy behaviour, the tax agent contributed either directly through deliberate actions or indirectly by not taking reasonable care in checking claims made.